February 7, 2011

Yield Spreads Augur Well for Equity, Muni Gains

According to this WSJ article, the difference in the yield between junk bonds and Treasuries with similar maturities is at its smallest (about 1.3%) since the credit crisis. 

There are plenty of reasons why this is the case. As investors struggle to find income and the corporate earnings picture continues to improve, taking the plunge in higher risk debt isn’t as scary as it used to be. But as I’ve said in previous posts, it is likely that such spread compression will drive market participants to other places.

One such beneficiary should be municipal debt, which on an after-tax basis actually yields more than junk in many cases. Even with all the concern over the health of local governments, muni debt is probably safer than that of struggling companies.

Dividend-paying stocks may also get some additional attention, especially those of larger companies. The liquidity and yield of these types of equities, in many cases, make for compelling portfolio additions.

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